By Anthony M. Freed
Once again wild swings in the markets have unleashed the bullish cries of bottom by the guestimating industry cheerleaders like Jim Cramer, the NAR, and similarly minded government ilk who believe we can all collectively wish our way out of this mess.
But the proverbial writing has long been on the wall, and we have yet to measure the depth of the losses from this financial fiasco.
What monsters are lurking in the nearby shadows?
I am not going to tell you anything you have not already figured out if you have been following news articles and blog posts about the current financial crisis and the mortgage industry with even a passing interest – they are the illegitimate offspring of subprime and Prime -what is commonly referred to as Alt-A – that is taking over the national spotlight (before being completely eclipsed by Option ARMs – to be covered in a subsequent aeticle).
An Alt-A mortgage, short for Alternative A-paper, is a type of U.S. mortgage that, for various reasons, is considered riskier than A-paper, or “prime”, and less risky than “subprime,” the riskiest category. Alt-A interest rates, which are determined by credit risk, therefore tend to be between those of prime and subprime home loans. A few of the more important factors are:The similarities between subprime and Alt A do not begin and end with their underwriting guidelines, either. An Alt-a default wave that began in 2008, is not expected to peak until 2011. Although combined Alt-A defaults is not expected to reach the level of subprime, all indicators reveal Alt-A is not performing as well as expected.
- Reduced borrower income and asset documentation (for example, “stated income”, “stated assets”, “no income verification”)
- Borrower debt-to-income ratios above what Fannie or Freddie will allow for the borrower credit, assets and type of property being financed
- Credit history with too many problems to qualify for an “agency” loan, but not so many as to require a subprime loan (for example, low scores or serious delinquencies, but no recent charge-offs or bankruptcy)
- Loan to value ratios (percentage of the property price being borrowed) above agency limits for the property, occupancy or borrower characteristics involved
In this way, Alt-A loans are “alternatives” to the gold standard of conforming, GSE-backed mortgages.
This should not be news to anyone, especially those who should be in the know.
As late as the spring of 2007, major national lenders were still aggressively marketing Alt-A products with with ridiculously vacuous underwriting criteria: A borrower could secure a no income/no asset documentation cash-out refinance loan, with a simultaneous second mortgage up to 95% CLTV, on a non-owner occupied investment property, with only a 620 FICO, two months PITI reserves and a debt to income ratio up to 60%.
Now everyone responsible for the mounting losses will throw up their hands in utter surprise that the golden child of the short lived post-subprime era was a bad idea too.
“,,,any changes purchase/underwriting criteria still clearly came far too late to prevent GSE (Fannie) from taking a direct credit hit, now that the Alt-A mortgage class is the latest area of mortgages to go through a meltdown, and many borrowers are defaulting at a seemingly parabolic rate each month and each quarter.”
Even as executives were in the midst of struggling to explain how they were blindsided by the rapid demise of their subprime divisions, they were also racing to expand Alt-A criteria to cover all but those borrowers with the very worst credit ratings.
They did not stop there, as they pressed on with the development of other exotics like Near Prime and Expanded Approval.
It was all done to maintain the market share and record origination levels they had grown addicted to. But who will they blame in the media for their greed driven and fiscally irresponsible business practices?
Why, all the lying cheating borrowers who did this to them, of course! Also from Jackson’s article:
“The strategy isn’t all that surprising, as nearly anyone in the mortgage business these days is looking for a reason to push the bad loans – and the losses associated with them – off of their books, and onto someone else’s. And in the case of Alt-A, there’s likely to be more than a just a fair amount of income misrepresentation, among other sorts of fraud.”
I am in love with this line of reasoning: The average American homebuyer- be they plumber or grocery clerk or postal worker – collectively conspired by the millions to defraud the financial industry out of 3 trillion dollars in about a five year period. And now they are cleverly concealing their new found fortunes by going through the motions of being foreclosed upon and thrown out on the street just to cover their tracks.
Really, how much can you be lying about if you only need to get yourself to a 60% DTI?
I know if they look at enough liar loans, they will find some liars. But that is missing the fundamental issue at hand here, that it was lax underwriting and low down payments initiated by the lenders, not the borrowers that are responsible for this mess.
I can remember as a kid asking my dad why someone would bother putting up a chain link fence that was only four feet tall. “Little fences are only for keeping good people out of trouble,” he told me.
And that is exactly what the lenders did not do when they developed and marketed these and other more complicated products like Pay Option Arms, they built them without the little fences that would have kept them and us out of trouble.
Let’s pretend for a moment that borrower overstatement of income on Alt-A loans really was so greatly overstated on average as to be responsible for 50% of all defaults on the books.
Imagine what the effect a simple underwriting requirement like a signed 4506T (the authorization to review tax returns) could have made.
They do not inherently prevent default on stated income and asset loans, but they certainly would have made borrowers who might be tempted to stretch the truth think twice about the consequences.
Instead, there was a culture were no one felt they had to be really honest with anyone else. The hunters set the traps – now they want to blame the animals for getting snared – and the media just eats it up.
Don’t be fooled by those who need you to stick your money into those raucous markets. The time will come, but it’s not here yet. And it should not be this difficult for the big brains to figure it all out.
The underwriting is on the wall, the deals are closed, the loans are booked, and the resets are coming like clockwork. Let’s all just accept that it is really no surprise to any of us.